The cryptocurrency has enjoyed a series of vertiginous ascents or speculative climaxes, sold off in the classic fashion of a burst bubble, and then after a few years of consolidation has come back with another big rally. Bitcoin entered this year in the grip of its latest speculative mania, which peaked in April, to be followed by a classic selloff. A drop in tech growth stocks had preceded the turn. It seemed a fair bet that another period of consolidation, at the very least, lay ahead before the next rally. Instead, bitcoin is almost back.
There are a number of potential explanations, none of them satisfying. There are some arguments that bitcoin could be viewed as an inflation hedge. It’s certainly regarded by many of its investors as a protection against currency debasement. And inflation expectations peaked earlier this year and then declined, only to come back again in the last few weeks. But against this, expectations for the Federal Reserve have shifted and it is now expected to be more aggressive than it was earlier this year — which would imply less reason to worry about dollar debasement.
Bitcoin also appears to be behaving more and more like a “risk on” asset, rising in price when stocks are doing well, bonds are doing badly, and people feel optimistic (even though this in general should also feel less need for a hedge against general debasement and disaster). Bitcoin’s peak earlier this year came roughly as stocks ended a protracted rally against bonds. The stocks/bonds relationship (proxied in the chart below by the ratio between the most popular exchange-traded funds for the S&P 500 and Treasury bonds of more than 20 years) has been almost horizontal for six months, and is in recent days showing signs of breaking out to the upside — just as bitcoin also breaks upward. Despite all the gloom, these two indicators might tell us that the mood is turning positive again:
All of this is unsatisfactory. Whatever the future for bitcoin, or other cryptocurrencies, they are too far from maturity to have reliable linkages with other asset classes. They are in what could charitably be called a growth phase, or uncharitably a speculative phase. Trends in the bitcoin price still have little reliable link to other critical variables in the economy, and much more to do with waves of sentiment as people try to work out the ultimate role in the economy of undeniably exciting technology .
For one possible good reason for bullishness towards crypto-assets, however, you might wish to read the latest LinkedIn post from my Bloomberg Opinion colleague James Bianco of Bianco Research LLC. An enthusiast for the possibilities of crypto-technologies, Jim suggests that the way the sector has responded to the clampdown by Chinese authorities — which came roughly as bitcoin was reaching its earlier peak — was “one of the most bullish things that has ever happened to crypto.” As he put it:
Nearly 50% of the computing power (called hash rate) of the bitcoin blockchain, pulled the plug, packed up, and relocated to another country in a few months. And no one noticed! It signals an incredibly resilient system. I believe this realization is contributing to BTC above $60k again?
He also points out that there is now an opportunity for other countries to take over the space previously occupied by China. Two years ago, China accounted for roughly three-quarters of all the computing power that went into mining bitcoin. Now that number is down to zero, while the combined North American share of the U.S. and Canada is close to a half. Particularly given the state of geopolitical rivalry between the U.S. and China, that is quite a turnaround in what could be a pivotal technology of the future:
Is the demonstrated resilience of the system, and its shift toward the West (even if countries like Kazakhstan and Iran maintain a significant and growing share of bitcoin activity) helping to push the price up again? Jim Bianco’s conjecture is better than mine, but on the whole all of us are still guessing. For the time being what is clear is that the demand for bitcoin as a speculative or investment asset is more resilient than it was only a few years ago. That’s an important development. If anyone has any ideas why this is happening, feel free to speak.
Book Club: Why Trust Matters
“A man I do not trust could not get money from me on all the bonds in Christendom,” J.P. Morgan, patriarch of the banking dynasty that still bears his name, told a congressional inquiry more than a century ago. “I think that is the fundamental basis of business.” As far as he was concerned, the first thing in credit was “character, before money or anything else. Money cannot buy it.”
Those words, spoken in the hearings that would lead to the establishment of the Federal Reserve, have always struck me as profoundly important. We need to take risks to grow and move forward; we also need to be prudent and save to be able to take those risks; but ultimately the key to the economy, and possibly human wellbeing, is trust. If you want to grow, make money, and build, you need to place confidence in a lot of people.
That is why it is such a disaster that trust within society is breaking down. Three years ago, before reporting to work here at Bloomberg, my old employers at the Financial Times offered me the chance to write a “swan song” article to sum up the 29 years I had spent there; the piece was headlined: “Finance, the Media, and a Catastrophic Breakdown in Trust.” It told the story of how readers had lost faith in me and in people like me. Financial media, and the media in general, are no longer trusted to tell the truth. This is true even if their business model relies on clients and readers believing they will get information right (something that applies to both of the media organizations for whom I’ve worked).
Beyond loss of credence in the media and possibly even in objective truth, the last decade or so has also seen serious erosion of trust in political institutions across the Western world, and in courts, markets and financial systems. Certainly, nobody trusts the banks. Notwithstanding arguments about why the bitcoin price has increased recently, the rise of cryptocurrency demonstrates that a large swath of society no longer trusts central banks or fiat money. If J.P Morgan is right, and I think he is, this suggests profound problems for society and the economy, and it grows very hard to see any way out.
That’s why I’m suggesting
Why Trust Matters: An Economist’s Guide to the Ties That Bind Us by Benjamin Ho as the next selection of the Bloomberg book club:
Published this year, the book is an attempt to pin down a working definition of trust and how it matters to the economy, using insights from experimental behavioral economics, and hence to give us an inkling of how to rebuild for everyone’s advantage. Clear, business-like and beautifully written, the book draws from a startling array of sources and disciplines, including evolutionary biology, sociology and particularly anthropology. It’s a slightly bigger and chunkier read than I usually offer for the book club, but it’s relevant and timely. The book suggests lots of avenues of thought that could help us work out exactly how to navigate the strange world in which find ourselves, a decade after the financial crisis seems to have destroyed trust in the financial system, and a year after the pandemic required everyone to put a lot of trust in everyone else.
Let me offer a few findings to whet the appetite. First, there is a clear correlation between the level of trust in society and growth. There is also a correlation with the effectiveness of the rule of law. Countries ranking low on trust include many with the greatest and most intractable development problems. China’s growth has been aided by high levels of trust — and the same is true of the highly successful countries of Scandinavia. Any given economic model is likely to work more successfully in an environment where people are more comfortable trusting each other:
Another fascinating point is that more developed societies grow more, not less trusting. This is ultimately because people in a modern industrial economy are used to having confidence in the system, while in more basic societies people are accustomed to knowing all individuals with whom they have to deal personally. They don’t want to trust people they don’t know.
The next chart shows the results of an experiment in game theory, in which anthropologists Jean Ensminger and Joseph Henrich asked people from different societies to play the “dictator” or “ultimatum game.” One player, “the dictator,” is given some money, and told they they need to share some with the second player. They can opt to share zero if they wish, and the second player will have no way to hit back.
Surprisingly, perhaps, most people do choose to share something. Even more surprisingly, people in more advanced societies share more, the anthropologists discovered after visiting contemporary Americans, remote hunter-gatherer tribes, subsistence farmers, and cash-crop farmers. Contemporary Americans, and people in other advanced economies, are more trusting than they seem. The results are summarized in the chart. Ho’s brief explanation:
[T]he trust game they ran was anonymous. Hunter Gatherers were used to trust and cooperation, but only if they knew with who. Otherwise, their system of favors breaks down. Modern Americans are used to trusting anonymously because we trust the system more than the person.
The uncomfortable corollary is that a loss of trust in the system would hit directly the market economy and modern society. That is why such a thing so potentially damaging, and why attempted solutions such as cryptocurrency (in which we no longer have to trust a central bank) have gained so much popularity.
We’ll be discussing the book live on the terminal on Wednesday, Nov. 17 (the week before Thanksgiving week), at 10 a.m. Eastern time, with author Ben Ho and my colleague Stacy-Marie Ishmael, the managing editor in charge of Bloomberg News’s crypto coverage.